FOCAL POINT M ANAGEMENT

Investment Advisory & Wealth Management Services

Strategy Update Summer 2013

Surprise, Surprise
There are always surprises, and the biggest one in the first half for financial markets was the apparent shift in the Federal Reserves policy stance which emerged after their June meeting. The shifting interest rate outlook changes the game: in a world accustomed to a global excess of dollars available at zero interest cost to borrow, the Feds policy shift creates some uncertainty and has an even greater impact on global investing. The changing interest rate outlook contributed to tremendous deviations in financial market returns during the first half of 2013: while U.S. stock markets posted strong gains of 11-12% during the first half, overseas developed markets saw only a 2% increase, and emerging markets in Latin America and Southeast Asia saw an 11% drop in their value during the period. Commodities were also hit hard, with gold seeing a drop in excess of 25% of its value during the first half of the year. Fixed income securities also fell, with declines witnessed across the board in U.S. government, sovereign and corporate bonds. While the interest rate situation creates some uncertainty, stocks can make further gains from here, but they will likely do so at a slower pace and with increased volatility. Stocks are still supported by reasonable valuations, particularly when compared to bonds. Additionally, corporations remain in strong shape and profit margins have been holding up better than many expected. That said, the higher volatility seen in late spring and early summer is likely to continue. First, the economy will most probably experience continued sluggish growth in the second and third quarters (probably close to 2%, near the 1.8% pace seen in the first quarter). Some of this slowdown will result from the delayed impact of the sequester (the automatic government spending cuts which are going into effect), and some is driven by weakening consumer spending. All else being equal, slower growth tends to be associated with higher levels of volatility. Secondly, and perhaps more importantly, the angst over central bank policy will help keep market volatility high. To the extent there continues to be uncertainty over the future direction of Fed policy, we are likely to see higher levels of stock market volatility. Looking out overseas, the global economy is still mired in a slower growth mode. Indeed, in the second quarter, many areas of the world appeared to be decelerating furtherparticularly many emerging markets. While there is less risk now of a widespread global recession than there was one year ago, thanks in large part to aggressive action

from the European Central Bank, overall global growth is still hovering around a relatively slow 3.0% to 3.5% rate. One surprising bright spot has been Japan. Following decades of economic stagnation, that countrys economy grew at an astounding 4.1% in the first quarter. In terms of Europe, the near-term threat of an outright breakup of the Eurozone has receded. There remain, however, ongoing threats. The banking system is fragile, undercapitalized and remains a source of risk (as witnessed in Cyprus earlier in the year). Real reform will require more political will than we have seen in Europe, and given the German elections in September, there may not be much progress until a new German government is formed. Outlook Stocks should continue to climb higher, but we could see continued back-and-forth action in prices. A startstop economy with shorter business cycles driven by the lumpy nature of unconventional policy continues to be the current playbook. Portfolio diversification and tactical positioning will be the key to outperformance as the economy and markets continue to stabilize and gain their footing. Volatility is here to stay, but we can make it our friend and not our enemy. We are moving gradually closer to clearer skies for investors, but gradual is the key word. I am more than happy to share thoughts with you in greater detail, and welcome any comments you may have. Thank you for your support.

Amin Khakiani July 17, 2013